How to Deal with Inaccurate Forecasts

Jovy Jader // Articles


September 2, 2019  

Many organizations that have implemented Enterprise Resource Planning (ERP) find themselves today wanting for supply chain improvements. While ERP may have enhanced integration among functions, Demand Forecasting, a key driver of the business process, has not really improved in some firms. Business executives need to realize that for ERP to be truly effective, they would have to develop their companies’ forecasting process.

Why Forecast?

In ERP, a forecast is an estimate of what will be sold in the future. The forecast number is used as a basis to plan materials purchases, production capacity, storage and transport requirements, and other resources such as manpower. Without a forecast, organizations react to demand as it happens and this may have negative repercussions especially if an organization does not have the luxury of time to react.

Consider the electricity in our homes. When we need light, we turn on a switch. Power flows instantaneously from the utility company. Yet, if electric companies fail to forecast the right amount of power supply in their assigned franchise area, consumers will find themselves without electricity at certain times. The reverse of this is if electric companies over-forecasted demand but comes out lower than projected. Consumers will have their power but will be forced to pay more in terms of higher rates to compensate for underutilized excess capacity.

The same scenario plays out for virtually all types of industries. Beverage firms need forecasts to avoid demand shortfalls or to keep themselves from over-producing. Soap manufacturers need forecasts to plan how much to import of their key but expensive raw materials. Bus companies need forecasts to know how many drivers they would need at a given time at a certain season. Petroleum firms need forecasts to find out how much crude oil to buy, as oil as a commodity is subject to ongoing uncertainty in prices.

Forecasts provide the basis for planning for revenue support. Sales departments can’t double their numbers if production doesn’t have the capacity. Marketing managers won’t see their initiatives fly if packaging suppliers follow a forecast that don’t allow for the delivery of new materials by a targeted date.

Forecasting is a difficult and challenging task. A wrong forecast may lead to overstocking in certain items and out-of-stock in others. Sales, costs, and working capital suffer from wrong and inaccurate forecasts.

How to Deal with Inaccurate Forecasts?

For Marketing and Sales Departments

  1. 1
    Firms need to know what drives true demand. Sales quotas and month-end targets do not drive demand. Consumers and users do. Firms should appreciate the buying habits of users and where their buying behavior is coming from. Market research is a definite must.
  2. 2
    Identify and eliminate demand volatility drivers. Temporary price-off promotions which do not create brand loyalty but only create revenue distortions is an example of a demand volatility driver. Consumers may buy more of a product when it is on sale but may stop buying it in favor of another when the promotion is over. Demand is thus inflated during a promotional period and may deflate significantly when it ends.

For Supply and Operations Groups

  1. 1
    Identify strategic stocks. Products with high variability in demand should have higher stock inventories versus products with more predictable demand. Not all products deserve the same targeted inventory levels.
  2. 2
    Reduce lead time. Products with long lead times are susceptible to inaccurate forecasting. If lead times could be shortened, there is a greater chance one can be more responsive. Imported products/materials generally have longer lead times than locally-sourced merchandise. An international clothing company decided to bring back their production operations to their home country in Europe because even as costs were lower overseas, shorter lead times at home made it easier to respond to changing customer preferences. Additional revenue and savings in inventories brought on by better forecasting more than offset the higher production costs at home.
  3. 3
    Move manufacturing differentiation closer to the customer. Keeping inventory in raw materials instead of in finished product makes the supply system more flexible to variations in customer demand. If inventories are mostly in finished products, businesses can only hope that customers will order what they have in stock.

Inaccurate forecasting is a reality. As customers become more informed and more value conscious and as the market becomes more competitive, organizations will find it more difficult to predict what and how much customers will buy. Demand forecasting is a basis for supply chain planning, in which the planning per se deals not only with what the forecasts dictate but also in managing key areas to respond to the ever so expected inaccuracies that come with the forecasts.

About the Author

Mr. Jovy Jader is a Management Consultant and Regional Speaker on Supply Chain Management. He has directed and implemented Supply Chain Management projects both local and international which have resulted to company-wide improvements in revenue, working capital, total cost, and service levels. Mr. Jader was formerly with Procter & Gamble Philippines and Coopers & Lybrand/PricewaterhouseCoopers.

Jovy Jader